An increasing percentage of tax advisors client base is now eligible for a Roth IRA, according to a survey of 500 tax advisors.
The survey, conducted by Fidelity Investments, found that 40 percent of investors working with tax advisors are now eligible to take advantage of the recent removal of income limits for Roth IRA conversions, up from just 13 percent last year. More than a third (35 percent) of these clients are expected to complete a conversion by year end, according to the study.
Here are some of the key findings:
Since two-thirds of tax advisors polled expect taxes to rise in the future, they believe that 43 percent of their clients would benefit from a Roth IRA conversion.
Tax advisors also indicated that 35 percent of their clients are expected to complete a conversion by year end.
Among tax advisor clients who are likely to convert to a Roth IRA this year, half will be converting all eligible assets from accounts such as a traditional IRA or 401(k) with a former employer.
The majority (54 percent) plan to take advantage of the one-time opportunity this year to split the taxable income between their 2010 and 2011 tax filing years.
Nearly half (44 percent) of the conversions are $50,000 or more.
We found investors are coming to us to inquire about the Roth conversion, said Chris McDermott, senior vice president at Fidelity. They had heard about it, and wanted to see if it fit into their situation. However, the majority of investors didnt understand it at the start of the interaction with their advisors.
Dealing with the resulting taxes from a Roth IRA conversion is a key consideration that investors need to weigh. In most cases, Fidelity believes that investors should avoid using proceeds from the conversion to pay the tax costs because it reduces the amount that can potentially grow tax free and could offset any tax savings gained by converting. However, according to the survey, half of tax advisor clients are planning to pay for their Roth conversion from the account being converted.
This does not necessarily mean that they will pay the entire tax bill from the account being converted, but tax advisors expect that half of their clients would pay for at least some of the tax bill from the account being converted, observed McDermott.
Although the survey didnt get into the reason, tax is a driver of not converting, he said. Its a key consideration. In the vast majority of cases, it doesnt make economic sense to pay the upfront tax out of the account.
However, there are other reasons someone might wish to convert a traditional IRA to a Roth IRA, he noted. There are estate tax benefits to a Roth conversion that are separate to the conversation about how you pay for the tax liability under the Roth conversion, said McDermott.. One of the potential benefits is no minimum distribution requirements, so you can pass it on to your heirs without having to take a minimum distribution during lifetime.
Amounts converted from a traditional IRA to a Roth IRA must be reported as income for the year of the conversion. However, for amounts converted in 2010 only, half of the income will be reported on the 2011 return and half on the 2012 return unless the taxpayer elects to report it all on the 2010 return.
The majority (54 percent) plan to take advantage of the one-time opportunity this year to split the taxable income between their 2010 and 2011 filing years, according to the survey.
One of the factors they need to consider is what their tax liability will be in 2011 and 2012, McDermott said. No one can predict where taxes will go, but you need to take a look at the things you can control and what you feel confident you know.
